UPDATE 2-More must be done on shadow banking -Fed's Tarullo

May 02, 2012|Reuters

By Dave Clarke and Jonathan Spicer

NEW YORK, May 2 (Reuters) - U.S. regulators should takesteps soon to strengthen government oversight of money marketfunds and short-term bank funding markets so that the "shadow"banking system can be better policed, a top Federal Reserveofficial said on Wednesday.

Fed Governor Daniel Tarullo said that while regulators havetaken many steps since the 2007-2009 financial crisis to betterregulate banks once considered "too big to fail," less work hasbeen done to make funding markets outside the traditionalbanking system less risky.

"Although some elements of pre-crisis shadow banking areprobably gone forever, others persist," Tarullo said at theCouncil on Foreign Relations. "Moreover, as time passes,memories fade, and the financial system normalizes, it seemslikely that new forms of shadow banking will emerge."

Tarullo singled out money market and tri-party repo marketsas areas where action should be taken in the "short-run."

Tarullo is the Fed's leading voice on regulation and hispublic support for stricter oversight gives weight to efforts byU.S. Securities and Exchange Commission Chairman Mary Schapiroto introduce new regulations for money markets.

Schapiro has so far been unsuccessful in gaining enoughsupport within the commission for tougher reforms for the $2.6trillion money market fund industry.

She has said further steps are needed to stop potentialproblems at money funds from spreading throughout the financialsystem, as happened in the 2008 credit crisis when the ReservePrimary Fund "broke the buck" with its net asset value fallingbelow $1.

The agency is considering requiring that funds set asidecapital against losses, restrict a portion of withdrawals oreliminate fixed share prices.

"Chairman Schapiro is right to call for additionalmeasures," Tarullo said.

The shadow-banking sector handles credit and leverageoutside traditional banking, and includes money market funds,and securities lending and repo markets, which use collateral tounderpin short-term financing for banks and brokers.

The Financial Stability Board (FSB), a global regulatorybody, is set to complete work on policy recommendations forshadow-bank regulation by November, when leaders of the Group of20 nations meet. The European Commission will propose shadowbank regulation for the European Union next year.

REPO MARKET STILL NEEDS WORK

Tri-party agreements, or repos, are a prime source ofshort-term bank funding and are backed by Treasuries or riskiercollateral, including mortgage-backed debt.

Fed officials, including Chairman Ben Bernanke, have pointedto problems in the repo market as a leading contributor to thefinancial crisis.

Earlier this year the New York Fed said it was consideringrestrictions on repo markets after becoming dissatisfied with anindustry committee's efforts to address concerns about theloans' risks.

The industry effort "fell short of dealing comprehensivelywith this problem," Tarullo said. "So it now falls to theregulatory agencies to take appropriate regulatory andsupervisory measures to mitigate these and other risks."

Asked how long it would take various U.S. regulators to giveclear details on a raft of planned financial reforms - fromBasel III capital standards to the Volcker Rule's ban onproprietary trading - Tarullo said it was reasonable to expectthose "some time next year."

Also on Wednesday, Tarullo is scheduled to meet in New Yorkwith the chief executives of several large banks to discussresults of the annual "stress tests" that were released inMarch.

The gathering should also give bank CEOs a chance to airgrievances over a set of proposed Fed rules the banks say go toofar and appear aimed at trying to make them smaller.

Still, Wall Street giants should be comforted by at leastone part of Tarullo's speech.

He said changes should be made to parts of an internationalagreement, known as Basel III, on the amount of liquid assetsbanks should have to hold in order to weather a crisis.

U.S. financial institutions are making good progress gearingup for Basel III, Tarullo said. "As a whole, we're quiteconfident that our banks are well ahead of even our acceleratedexpectations."

Banks want regulators to state clearly that if a crisis wereto occur they could draw down their liquidity below the minimumlevels laid out in the agreement.

Tarullo agreed, saying the current proposal could promote"liquidity hoarding."

The proposal "should be better adapted to a crisisenvironment as, for example, by making credibly clear thatordinary minimum liquidity levels need not be maintained in themidst of a crisis," he said.